It is an indicator of a market's evolution as a function of the behavior of the quotations of the most representative stock. It comprises a group of instruments, shares, or debt, and seeks to capture the characteristics and movements of the value of the assets that conform it. It is also a measure of the yield of this group of assets during a given period of time.

USES AND APPLICATIONS

The indices constitute a basis to identify the perception of the market in relation with the behavior of the companies and the economy.

The indices are also used to:

Identify the perception of the market in relation with the behavior of the companies and the economy.

Manage portfolios professionally, through the use of clear performance references.

Carry out an efficient risk management of the market.

Offer new products such as structured notes, exchange traded funds (EFTs), and derivatives on indices, among others.

BASIC CRITERIA FOR THE CONSTRUCTION OF AN INDEX:

To build an index two steps are required. The first one is to select the basket of shares or group of shares that belong to the index, and the second, to determine the manner in which each one of these shares is going to be weighted within the index.

First step: Basket Selection:

It is the procedure through which the shares that are going to be included in the index are defined. There are three methodologies that are widely used internationally to select the basket, and they depend on the variables that are considered. These variables are: the capitalization level of the company, the liquidity of the shares, or a combination of these two. The definition of which methodology is to be used depends mainly of the depth of the market, for example:

By Liquidity (Marketability):
The liquidity is defined as the ease to purchase or sell a share at a given time and at a fair price. For this reason, when you select a basket taking into account its liquidity, the shares selected are the most traded in the market. Some measures of liquidity adopted by the market are: the traded volume, the rotation, the frequency and number of operations, among others. This last variable is the most used in the less liquid markets.

Market Capitalization:The market capitalization is defined as the value of the companies at market prices.

Mixed:Takes into account both of the preceding criteria together: liquidity and market capitalization. This is the methodology that is used most internationally.

Second step: Weighting Method:

Once that the shares that comprise the basket have been selected, they are weighted within the index. The weighting establishes the importance of each share. With that purpose, a coefficient that relates such relevance is calculated.

A weighted index assigns the most active and representative companies of the exchange a larger relative importance within the market. The main methods of weighting that define the type of index, are: (i) Market Capitalization and (ii) Liquidity or profitability.

TYPES OF STOCK INDICES:

1.

Market Capitalization:It attempts to reflect the behavior of the prices of the shares in the index, weighing each instrument within the index according with the size of the company in terms of market capitalization:

Market Capitalization: It reflects the total value of the capital of a company, according to the price at which its shares are quoted.

Adjusted Capitalization: Proportional part of the company, different from the one in the hands of investors with controlling interests (Floating).

2.

Liquidity or profitability:
The objective of this type of tools is to represent the behavior of the prices of the shares in one index, giving a weight to each instrument according to its liquidity level.

3.

Prices:
The price indices base their calculation methodology of the arithmetic sum of the prices of the shares that comprise the basket. These indices are not so common and their function is the same described in the preceding cases.

ESSENTIAL CHARACTERISTICS IN AN INDEX

When building an index, it must have five essential characteristics:

Completeness:
The index must reflect, for a given risk profile, the universe of opportunities available to investors. The more complete is an index, the more it will represent the universe of assets to follow. A complete index must provide the largest diversification.

Reproducibility:The investor must be able to create a portfolio with a part or all the assets that comprise the index, and in that manner be able to reproduce the behavior of the index.

Clear and widely published calculation methodology:The rules that define an index must be well defined, be clear, transparent and must be available for the investors. Such rules must contribute to anticipate the behavior of the index in front of the changing market conditions.

Precise and with complete data sources:
The data used in the construction of indices must be precise, complete and available for third parties.

Low level of rebalancing and transaction costs:All the indices require rebalancing with the purpose of maintaining the basket aligned with the methodology. In general, a lower level of rebalancing implies less transactional costs and facilitates the following of the index.